Foot on the Gas

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Gas prices hit a thirteen-year high last week – $38.18 per barrel on Wednesday – inspiring concern amongst many Americans that high energy costs could slow the already sluggish growth of the US economy. Reviews coming from experts in the field are mixed however. Thus far, there appears to be no clear consensus as to whether prices will continue to rise and perhaps more importantly, how much the price of oil will impact overall economic growth in the US.

Some analysts suggest that demand could drive prices beyond $100 per barrel and induce a global economic recession. Others suggest the hike is temporary and that, overall, the US is far less vulnerable than it has been in the past to sudden price fluctuations. Regardless it looks like gas prices may be another “hot button issue” that both Kerry and Bush will have to address in the coming months.

The sudden hike in prices is being blamed on record high demand in both the US and in China – demand, which has not decreased in spite of price increases. China alone is estimated to consume 5.4 million barrels per day in 2004. Overall, the Washington Post Reports that world demand grew by 1.4 million barrels per day last year and is expected to grow an additional 1.5 million barrels this year.

On the supply side, members of the Organization of Petroleum Countries (OPEC) report that they are “overproducing above [their] quotas” and are currently scheduled to cut supply by 1 million barrels per day beginning April 1st. The cartel is due to meet on March 31st to discuss whether to implement the reduction as planned.

According to Senior Energy Analyst Julian Lee of the Center for Global Energy Studies in London, “There is very little incentive to lower production when prices are at this level.” At the same time, according to SG Securities, “failing to confirm April’s cut – and to implement it – would show OPEC as unwilling to control the oil market or even incapable of doing so. Hedge funds would punish and OPEC perceived as weak-willed by quickly liquidating, or even reversing their long positions, with the resulting wave of selling triggering a price collapse.”

In addition to concerns related to the actual supply of crude oil, it has also been reported that refineries in the US and elsewhere have reached their production ceilings and that gas inventories are lower than they have been in the past. According to estimates by PFC energy, a Washington consulting firm, average global demand will exceed refining capacity by the end of this year. Ed Silliere, vice president of risk management at Energy Merchant Corp. notes that, “we have very low crude inventory stocks, low gasoline inventory right now. We’re not seeing the buildup (of stocks) in the rate we normally see.”

“The whole system is really stretched,” comments Roger Diwan of PFC energy, “that raises the risk of price spikes due to regional market dislocations.”

All of these factors suggest that the price of oil may go beyond, $40 per barrel. “The question is not what is going to get (crude) to $40,” notes Silliere, “it’s what’s going to stop it from getting to $40.”

High gas prices are particularly detrimental to the airline and chemical industries and generally make investors and consumers nervous. “You’re not going to see companies taking down guidance because of rising oil prices,” comments Jeff Kleintop, of PNC Financial Services Group, “But if job growth doesn’t pick up and fuel prices stay this high, that could call into question the overall pace of economic growth, which certainly would have an effect on businesses.”

According to Buttonwood of the Economist, Goldman Sachs revised its 2004 economic growth forecast from its original 4.6% to 3.8% primarily due to the increasing price of oil. Overall comments Buttonwood, “America may be more efficient than it was, but it is far from immune to higher prices. For consumers, the recent sharp rise in petrol prices—which hit an all-time high this week—is, in effect, an increased tax burden. And it comes just as the effects of Mr. Bush’s (official) tax cuts start to wear off.” The Automobile Association voiced similar concerns commenting that, “unstable gas prices make budgeting for fuel costs extremely difficult for families and businesses.”

In addition, notes Buttonwood, “wholesale prices have been rising much faster than the price at which companies are able to sell their wares. To stop profits from falling, American companies must keep a tight lid on labor costs… A prolonged rise in the price of oil and other commodities would make this problem still more acute: America’s jobless recovery is likely to stay jobless. This would eventually kill the recovery.”

In spite of these concerns many analysts suggest that current prices are really not as extreme as they appear and are unlikely to have any major impact on the US economy, or spur an energy crisis. In real terms, current prices are still far below record high of 1979, when oil was being sold at $44 dollars per barrel, or $100 per barrel when adjusted for inflation. In 1981 consumers willingly paid the equivalent of $2.83 per gallon, making the current high of $1.74 look like a bargain.

“Look beyond the most energy intensive sectors, and the notion that high oil prices are quashing demand and wrecking firms is overdone. One reason: OECD economies are less energy-intensive than three decades ago when the first oil shocks occurred.”

“American’s may whine about it [high gas prices]” comments Roger Diwan of PFC energy, “but they aren’t in pain because the oil price is $35.”

It has also been noted that recent hike is unlikely to last for long and is to some extent typical of what happens every year. “The prices that you see now will not be with consumers during the summer,” predicts Jacob Bournazian of the Energy Information Administration. Bournazian explained that gasoline reserves often decrease during February and March. Last year, this lead to a price increase in March and April followed by a decline in May when supplies returned to normal; “Maybe recovery will be in April rather than May.”

Well, maybe our entire economy isn’t at risk but that doesn’t mean that American consumers should not take the current price hike seriously. The hike re-emphasizes how dependent we are on a resource that is being produced in some of the most war-torn and unstable parts of the world, the Middle east and Venezuela – places where the success of the current administration’s foreign policy is certainly questionable. In addition, given that most American’s are feeling protective of the limited economic growth that has occurred in the last few months, high gas prices may very well be one of the little things influencing voters in November.


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